Bear Stearns Subprime Funds May Draw U.S. Charges, People Say

Bear Stearns Subprime Funds May Draw U.S. Charges, People Say

June 16 (Bloomberg) -- Federal prosecutors and the U.S. Securities and Exchange Commission may bring criminal and civil charges in a probe of Bear Stearns Cos. hedge funds whose collapse ignited the subprime mortgage crisis last year, people familiar with the investigations said.

The U.S. Attorney in Brooklyn and the Washington-based SEC may announce the actions as soon as this week, said one of the people, who declined to be identified because the case isn't public. Prosecutors told a New York state judge last month they would decide by mid-July whether to bring a criminal case against former Bear Stearns hedge fund managers Ralph Cioffi, 52, and Matthew Tannin, 46, a lawyer at the proceeding said.

``It was always a question of when the indictments would start rolling out, it was not a question of if,'' said Jacob Frenkel, a former federal prosecutor in private practice in Maryland. Indictments are inevitable ``because of the clamoring for accountability for anyone of note with what would be perceived as a substantial role in the mortgage-driven economic crisis.''

Assistant U.S. Attorney Sean Casey in Brooklyn asked a judge on May 13 to stay a civil lawsuit against Bear Stearns Asset Management, Cioffi and Tannin, according to a lawyer at the hearing who declined to be identified because he wasn't authorized to discuss the case. Prosecutors don't want the men to get access to documents that may complicate a criminal trial, Casey said, according to the attorney.

Securities fraud charges may be filed against Cioffi and Tannin within the next week, the Wall Street Journal said today, citing a person familiar with the situation.

Failed Bets

Bear Stearns spokeswoman Elizabeth Ventura didn't return a call seeking comment. Cioffi's attorney, Edward Little of Hughes Hubbard & Reed, and Tannin's lawyer, Nina Beattie of Brune & Richard, declined to comment. Robert Nardoza, a spokesman for Brooklyn U.S. Attorney Benton Campbell, and SEC spokesman John Heine also declined to comment.

Johnston Whitman Jr., a lawyer for Navigator Capital Partners LP, the plaintiff in the New York state court suit, didn't return calls seeking comment about the hearing.

Cioffi managed the two funds that collapsed and Tannin served as his deputy. The funds invested almost all of their assets in subprime-mortgage-related securities. The bets failed last June when prices for collateralized debt obligations linked to loans plummeted amid rising late payments by borrowers with poor credit histories or heavy debts.

Fund Withdrawals

CDOs are created by packaging assets including bonds and loans and using their income to pay investors. The securities are divided into different portions of varying risk and can offer higher returns than the debt on which they are based.

As the securities dropped in value, the funds' creditors demanded more collateral. Bear Stearns extended $1.6 billion in credit to one of the funds before seizing its assets in July. Both funds filed for bankruptcy protection two weeks after the firm told investors they would get little if any money back.

Cioffi left the firm in December amid government inquiries. Prosecutors and the SEC were examining whether he withdrew money from two funds before their collapse, three people with knowledge of the matter said at the time.

Since the failure of the two hedge funds in July, investors and government entities have said banks and financial companies such as Bear Stearns knew their underlying investments weren't worth what they were telling shareholders.

Barclays Plc, an investor in one of the funds, sued the New York-based bank last year in Manhattan federal court. London- based Barclays claimed it was misled about the health of the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund Ltd.

Countrywide, American Home

That fund, together with the Bear Stearns High-Grade Structured Credit Strategies Master Fund Ltd., held as much as $20 billion at one time, according to the Barclay's complaint.

The credit crunch led to lawsuits against other lenders including Countrywide Financial Corp., American Home Mortgage Investment Corp., Citigroup Inc. and JPMorgan Chase & Co.

Investors have claimed that former officers of Melville, New York-based American Home concealed the increasing number of high-risk mortgages issued before that company's bankruptcy in August, according to court papers filed in Central Islip, New York, federal court. They also sued seven underwriters, including Citigroup and JPMorgan, claiming they were negligent in handling American Home's stock offerings.

Bear Stearns agreed to sell itself to New York-based JPMorgan in March after a run by clients and lenders threatened it with bankruptcy. The collapse ranked along with Drexel Burnham Lambert Inc. as one of the biggest in Wall Street history.

Cayman Islands

The funds tried to liquidate in the Cayman Islands before a U.S. judge held that New York was a more appropriate jurisdiction, ruling they can't shield their U.S. assets from lawsuits.

Bear Stearns, Cioffi and Tannin are named as defendants in the Barclays lawsuit. The British bank accused Cioffi of withdrawing his personal $2 million investment in the fund in March 2007, at the same time Bear Stearns persuaded Barclays to double its investment by hiding performance problems that were revealed later, according to the complaint.

Barclays said it lost ``hundreds of millions of dollars.''

Cioffi, Tannin and others at Bear Stearns hid the fund's true performance, reporting it as ``positive'' or ``slightly negative'' when it had diminished by as much as 38 percent, according to court papers. Internally the two men discussed the ``wipe out'' of the fund, according to the complaint.

Tannin had direct contact with Barclays about the investment, the bank said in the complaint.

`Working Beautifully'

``You will be happy to know that we are having our best month ever this February,'' Tannin wrote in an e-mail to Barclays risk manager Angus McIsaac last year, according to court documents. ``Our hedges are working beautifully. We were up 1.6 percent in January and are up 2 percent so far in February.''

Bear Stearns deceived Barclays from March 2006 until at least mid-June 2007, Barclays said in its amended complaint.

Indictments against Cioffi and Tannin may be just the start of a U.S. probe of the credit crisis, Frenkel said.

``We're likely to see cases from the top all the way down to the mortgage brokers,'' he said.

``It was a very high-profile failure,'' Christopher Clark, a securities law attorney Dewey & LeBoeuf, said of the collapse of Bear Stearns. ``There's always going to be scrutiny after a well-publicized failure.''

The bankruptcy cases in the U.S. are Bear Stearns High- Grade Structured Credit Strategies Master Fund Ltd., 07-12383, and Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Master Fund Ltd., 07-12384, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

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